With the US dollar index reaching its highest level since 2017 in April, Mark Nelson takes a look at what has been behind the greenback’s recent resilience.

Reflecting on April

What happened?

The US dollar index, a measure of the value of the US dollar relative to a basket of foreign currencies, rose in April. Although the rise was relatively modest, the index hit a two-year high during the month, despite Bloomberg consensus estimates being for the dollar to weaken over the course of 2019.

Why?

Since early 2018, the US dollar has performed strongly supported by the relative outperformance of the US economy and the Federal Reserve’s efforts to normalise monetary policy, including raising rates and shrinking the size of its balance sheet. However, having forecast further rate rises during 2019 in December of last year, the Fed changed course in January, admitting that the case for tightening monetary policy had weakened as financial conditions tightened and the outlook for global growth stalled.

Since then the Fed has taken on an increasingly dovish tone to the extent that the market, based on Fed fund futures, now believes there to be more chance of a rate cut this year than a rate hike. This dovishness from the Fed, combined with some signs that the US economy might be beginning to falter, led to a generally bearish view on the US dollar. Following January’s Fed meeting, the median estimate for the US dollar index at the end of the first quarter was 95.7, according to Bloomberg, but it ended the period comfortably higher at 97.3. Current estimates for the index at the end of the second quarter and at the end of the year are 95.8 and 93.8, respectively, below current levels.

What to take away from it?

While the resilience of the US dollar may have come as a surprise to some, it is important to remember that currencies are a relative call and not an absolute one. Although there have been some signs of weakness in the US economy, it continues to perform at a level above that of other major economies including the eurozone and the UK. PMI data in the US remains well above the 50 level that separates expansion and contraction, while GDP data released last week showed that the world’s largest economy grew at an annualised rate of 3.2%, well above expectations. Furthermore, following the Fed’s dovish turn in January, a number of other central banks have followed suit, with the European Central Bank recently declaring that it does not expect to raise interest rates this year. The US dollar remains a high yielding currency relative to some of its developed market peers.

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